Discuss about the Private Equity Performance.
In modern world, the pressure is greater than the earlier times which has created a huge impact on the running of business. There is a wide range of instruments in the derivative world, which have to be considered and handled in today’s world. The costs have increased to a larger extent as the inefficiencies of operations has increased. The range of assets is growing endlessly, by the passage of time and thus, the requirement of managing such assets is increasing. The instruments of derivatives and equity had arrived much earlier, but the use is growing in the recent times. The private banks and fund managers are engaged in the usage of new types of market instruments. The instruments carry a huge amount of risk in the manner of processing and others, which form a part of the portfolio of the client. There are a number of areas which requires variances and development due to the challenges in terms of the structure of an organization, development of products, process of investments, communication structure, legal and compliance, management of risks etc.
The intelligent managers are growing at a faster pace by the creation of new products and markets, by shifting from the traditional strategies and ideas to a modernize market ideology and strategies (Aouni et al., 2014).
Portfolio and performance of Equity
As stated by Aouni et al., 2014, the emergence of financial economy has lead to substantial advantages for the mediocre- income countries and the developing ones, globally. The opening of the financial plans has brought about great deal of motivation for the investors all around the world. They are able to expand and specialize in the choice of investments, in the local and international assets, which has increased the rate of returns as per their expectations. They are also able to increase their financial ideas and also fund the plans of expansion. The investment procedure is becoming more efficient which is leading to a boost in the living and other standards of investors.
Globalization of financial markets has demonstrated a double sided nature. The country which has increased the economic growth, through liberalization has also increased the risk of crisis in the financial growth and development. Portfolio flows has been a major controversial aspect of financial downfall in most countries across the world.
As stated by Klingebiel, & Rammer, 2014, Asset allocation is the strategy to balance the risks and rewards, in which the portfolio assets are apportioned as per the requirements of an individual. There are two major forms of portfolio allocation which are as follows:
Strategic asset allocation:
It requires the setting up of targets for the allocation and then rebalancing of such portfolio in a periodical manner. The procedure is similar to the buying and holding and not the trading concept. The allocation targets changes over a period of time as per the change in the investor’s goals and objectives and as per the horizon of time.
Tactical asset allocation:
It allows a range of percentages in a class of assets which consist of a minimum and maximum percentage of acceptances by an investor, in order to gain advantage from the market conditions and factors. Thus, one can move upward to the higher end of range when the stock expectation to grow better increases; and move towards the lower end of range after the expectation grows miserable and depressing.
As discussed by Bodie et al., 2014; for the management of investment, there are two basic approaches:
Active management of asset:
It is based on a fundamental principle that, by following a particular style of analyzing produces returns and rewards which can control the market activities. The inefficiencies present in an economy can be turned into an advantage, and it is escorted with higher than average costs.
One who is in the favor of the approach of active management, the selection of the stock is usually based on the following styles:
Top Down approach
One, who follows such approach, firstly looks at the whole market scenario and policies which help in the determination of the likelihood of such industries which will grow well, given the present cycle of economic flow. After the making of the choice, specific stocks are selected on the basis of companies which will prove to be an advantage as per the particular industry.
Bottom Down approach
One, who follows such approach, ignores the conditions of market and the trends which are expected to continue for every year. The companies are put under an evaluation procedure, in which they mark on the strength of their financial statements and other criteria. The main ideology and concept behind following such approach, is that a strong company is likely to develop and grow no matter what economic and market conditions occur and prevail.
Passive management of asset:
It is based on a principle, that there is efficiency in every market scenario and that the returns from the market cannot exceed in a regular manner. The investments of lower costs which are to be held for a longer term can help in the gathering of the best returns and advantages.
One who is in the favor of the approach of passive management, the selection of the stock is usually based on the following concepts and theories:
Efficient market theory
The above theory forms the basis of an idea that the information which creates an impact an emphasis on the market and economy is easily available and processed by all the investors. The information consists of changes in the management of the company and interest rate announcements and others. The believers of such theory consider that there can be no way to thrash the market average.
To gain advantage from the efficient market theory, index funds can be used. Also, a portfolio can be developed which would be a mimic of a special index. The index funds mostly consist of transaction costs and expense ratio, which are lower than the average of the same. They help in surpassing the actively funds which are managed well and have higher costs and expenses.
Investors must consider the need of investing in a fast developing firm or low priced industries. These judgments can be passed by looking at the key financial metrics described below:
The style of growth and returns decides the investor’s point of view of deciding the portfolio to be considered. An investor looks for the firms that have higher earnings, rates of growth, return on equity, margin of profit and lower yields of dividend. The Investing on growth is based on the idea that, if an industry has all the above features, then it is earning a lot in terms of monetary value and also is innovating in its field of service. Thus, the growth is at a much greater pace and also it is in the process of the reinvestment of its majority earnings to continue the growth stability and development in the future times.
The style of investing focuses on the trading of strong industries at a good value. They look for a lower price to earnings and price to sales ratio and a higher yield of dividend. The value style shows the price of buying and investing.
Also, the preference for investing in small or larger companies is a question of investors. Thus, the measuring capacity of a company size is called capitalization of market or cap for short. The capitalization of a market is the number of shares outstanding, of a stock which is multiplied by the price of share.
Few investors believe that small capitalized companies are capable in the deliverance of better returns as they have huge amount of opportunities for development and are swifter in nature. However, there is a high risk for the greater returns which can be derived from those small caps. Also, the firms which are smaller in size have lesser resources and often they have less diverse lines of business. The share prices are much wider and flexible which cause huge losses or gains. Thus, investors can be comfortable in undertaking such extra levels of risk, if they want to acquire greater rewards and returns.
The major risk avoidance investors are more comfortable with the stocks of larger caps. The larger caps such as Microsoft and GE have been around for a while and have overpowered the industries. These industries are unable to develop in a quick manner as they already are so huge in nature and size. However, they are unlikely to get out of the business without any warning. The larger cap investors can be expected to gain slight lower returns as compared to the smaller caps. But, the risk is higher in smaller caps and larger in larger caps (Beringer, Jonas & Kock, 2013).
Thus, the above decision should be taken as per the style which will be a fit for the investors and will feel comfortable while holding for a longer term.
A risk is the measure of possible value of losing or gaining of expected returns, delivered from an investment. It is very uncertain and there are various types of risks which form the part of the market and economy. As stated and discussed by Pinedo & Walter, 2013 the risks are defined and described below:
To make suitable recommendations and decisions from an investor’s point of view, the concept of risk undertaken while making an investment must be understood well and efficiently. Every investment carries certain amount of risk and vulnerability which is associated with the nature and amount of risk which can be overcome by an investor. One should understand the trade off requirement between returns and amount of risk which are assumed by investors who are willing to face such risks in order to achieve their financial goals and objectives.
Interest Rate Risks
It is a possibility of a debt with fixed rates to decline in the terms of value, which is a result of a potential increase in the rate of interest. The investors on buying the securities with a fixed rate of return expose themselves to a higher rate of risks. This is possible for bonds and stocks and can’t be denied.
The measuring of the risks which are in association with the particular securities and bonds are considered under the business risks. It is also known as unsystematic risk and all businesses in the similar industry comprises of similar business risks. To be more specific, all the business risk refers to the possible situations in which the stock or bond issuer faces bankruptcy and become unable to pay off the interest and principal amounts in case of bonds. Also, a common and easy way for the avoidance of such unsystematic risks is the diversification by the buying of mutual funds, as they hold stocks and bonds of many various companies.
The possibility of a particular bond issuer to not make the payments or principal repayment as per the expected rate of interest is referred to as the Credit risk. The higher interest rate of bond increases the credit risk of a particular bond.
The risk of security which was issued with the status of exemption, have a potential expectation to lose the status before the maturity. Since, the bonds of municipal nature carry a lower rate of interest than the fully taxable ones; the holders of bond will have a lower yield as per their expectations.
The possibility of a bond security to be called up before the maturity period is known as the call risk. It moves parallel to the risk of reinvestment and the bond holder must be capable of finding an investment which can provide same amount of income for the amount of risk. When the rates of interest are declines, call risk becomes more active as the companies trying to avoid expense will redeem the issue of bonds and replace with lower rate of interests.
The risk of purchasing power and inflationary is used interchangeably and, it is the chance of an asset to erode off as inflation causes decline in the currency of a country. It is also the risk of an investment declination, which is caused by the future inflation. In order to fight strongly against such risks, appreciable investments should be taken resort of, as they can stay ahead of inflation over a much longer period of time.
It refers to the possibility of an investor to be able to buy or sell an investment and as per the desire and sufficient requirements as there are limited opportunities. It can be overcome by sale of real estate and in most cases there is no difficulty in the sale of such property and assets.
Systematic risk and market risk is interchangeably used and it refers to the risk which can affect all the securities in a similar way. It is a risk which cannot be controlled by result of diversification and the important point is the correct way of recommendation of mutual funds.
The bonds which are on the verge of becoming due are often forced to buy securities which do not provide same income levels, unless the credit or market risk capability of the investor increases. It is the risk which the declining rate of interest will lead to decline in the flow of cash from an investment. It happens when the payments of the principal and interest rates are reinvested at lower rates.
Political or legislative Risk
The risk which is associated with the possibility of the actions of government or social changes and results in the lowering of the value is termed as social, political or legislative risk.
Currency or Exchange Risk
It is a type of risk which arises from the fluctuations in currency of one country with the country. If a country’s asset comprises mainly of foreign assets, then it can be a major issue, as the risk increases when the currency of such country drops particularly (Teller & Kock, 2013).
The risk of currency is lower in case of long term investments as they have time to level off the risk over the time period.
Thus, on the survey of the various types of investments done above, we can get an overall view that most of the investments are full of risk and are unpredictable on majority basis. The various approaches of investments are described above which very well explains the risk and reward of the same. The global financial structure and economical conditions are changing and the requirements of the investors are changing accordingly. The pattern of the investor and the trends followed by the modern investors are explained above.
Thus, we can conclude that there various factors and instruments which define the nature of risks. The instrument which can perform the best is analyzed and thus to take a portfolio decision, one needs to attain a super knowledge about the different theories and approaches connected with the same. The best analysis tools should be used and performed and the risk and rewards must be evaluated as per the requirements of the investors. The investors must be highly updated with the types and manner to avoid all kinds of risk which prevail in the market place. The risk considerations for both the short and long term investors are provided which concludes that long term risks can be avoided more easily and strongly.
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Beringer, C., Jonas, D., & Kock, A. (2013). Behavior of internal stakeholders in project portfolio management and its impact on success. International Journal of Project Management, 31(6), 830-846. Available online at https://www.sciencedirect.com/science/article/pii/S0263786312001627
Bodie, Z., Kane, A., & Marcus, A. J. (2014). Investments, 10e. McGraw-Hill Education. Available online at https://188.8.131.52:8080/dspace/handle/TVDHKT/22462
Klingebiel, R., & Rammer, C. (2014). Resource allocation strategy for innovation portfolio management. Strategic Management Journal, 35(2), 246-268. Available at https://onlinelibrary.wiley.com/doi/10.1002/smj.2107/full
Pinedo, M., & Walter, I. (Eds.). (2013). Global Asset Management: Strategies, Risks, Processes, and Technologies. Springer. Available online at https://books.google.co.in/books
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